Contents Series Title Page Copyright Dedication Foreword Acknowledgments Introduction Part I: Trend Theory Chapter 1: Redefining Trend Chapter 2: Classical Trend Model OBJECTIVE OF THE MODEL INPUTS MODEL DEFINITION RULES FOR THE MODEL APPLYING THE MODEL SUMMARY Chapter 3: Neoclassical Trend Model OBJECTIVE OF THE MODEL INPUTS MODEL DEFINITION RULES FOR THE MODEL SUMMARY Chapter 4: Determining Trends FUNDAMENTALS FOR THE LONG TERM SWING POINT LOGIC IDENTIFYING AND LABELING TRENDS SUMMARY Chapter 5: Qualifying Trends USING SWING POINT TESTS TREND CONTINUATION AND TRANSITIONS RETEST AND REGENERATE SUMMARY Part II: Application of Trend Theory Chapter 6: Preparing to Trade OVERVIEW OF TRADING STRATEGIES RISK VERSUS REWARD TIME FRAMES SUMMARY Chapter 7: Entering and Exiting Trades SUPPORT AND RESISTANCE PRICE ZONES, NOT LINES DEFINING ENTRY AND EXIT POINTS A TRADING EXAMPLE: COMBINING TECHNICAL EVENTS SUMMARY Chapter 8: Reversals and Price Projections PRICE REVERSALS PRICE PROJECTIONS SUMMARY Chapter 9: Time Frames TIME FRAME ANALYSIS TIME FRAME INTEGRATION ESTABLISHING A TRADING BIAS TRADE TREND MATRIX SUMMARY Chapter 10: Markets, Sectors, and the Trading Cube GENERAL MARKET MARKET SECTORS THE TRADING CUBE SUMMARY Chapter 11: Trading Qualified Trends EXAMPLE OF A QUALIFIED TREND ENTERING A TRADE EXPLOITING THE TREND EXITING THE TRADE FLIPPING TRADING POSITIONS CONCLUDING THOUGHTS Notes INTRODUCTION CHAPTER 1: REDEFINING TREND CHAPTER 2: CLASSICAL TREND MODEL CHAPTER 3: NEOCLASSICAL TREND MODEL CHAPTER 4: DETERMINING TRENDS CHAPTER 5: QUALIFYING TRENDS CHAPTER 6: PREPARING TO TRADE CHAPTER 7: ENTERING AND EXITING TRADES CHAPTER 8: REVERSALS AND PRICE PROJECTIONS CHAPTER 9: TIME FRAMES CHAPTER 10: MARKETS, SECTORS, AND THE TRADING CUBE CHAPTER 11: TRADING QUALIFIED TRENDS Glossary of Key Terms About the Author Index Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Australia, and Asia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding. The Wiley Trading series features books by traders who have survived the market’s ever-changing temperament and have prospered—some by reinventing systems, others by getting back to basics. Whether a novice trader, professional, or somewhere in-between, these books will provide the advice and strategies needed to prosper today and well into the future.
For a list of available titles, visit our Web site at www. All rights reserved. Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.
No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750–8400, fax (978) 646–8600, or on the Web at www. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748–6011, fax (201) 748–6008, or online at http://www.com/go/permissions. Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials.
The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages. For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762–2974, outside the United States at (317) 572–3993 or fax (317) 572–4002.
Wiley also publishes its books in a variety of electronic formats. Some content that appears in print may not be available in electronic books. For more information about Wiley products, visit our web site at www. Library of Congress Cataloging-in-Publication Data Little, L.
Trend qualification and trading: techniques to identify the best trends to trade / L.—(Wiley trading series) Includes bibliographical references and index. Stock price forecasting.63′222—dc22 2010049530 To my loving wife, Nadereh, who has always stood by with encouragement while providing direction, insight, and active concern. To my son and daughter, Arman and Anaheed, who are both blessed with bright and inquisitive minds and now, as they near adulthood, have boundless opportunities before them. Foreword The essence of all successful investing and trading is trend following.
Trend following is not just a style or an approach to the market; it is the heart and soul of all profits. There is no way to escape the fact that you must embrace an uptrend of some sort if you hope to eventually recognize a gain. Even the most long-term dedicated value investors, who focuses on fundamentals and buys out of favor stocks, needs to have his or her insight eventually validated by a positive trend. At the other extreme, the aggressive day trader needs a trend of some sort even if lasts for just for a few minutes.
Market success and trend following are inescapably connected. Despite the essential nature of trend following to the investment process, the literature on the topic is woefully lacking. Platitudes such as “the trend is your friend,” “buy low, sell high,” and “cut losers and let winners run” constitute much of the discussion about riding a trend. In many ways trend following is like the famous dicta uttered by Supreme Court Justice Potter Stewart in regards to pornography: “I know it when I see it.” Trends are always easy to see in retrospect.
They are almost always painfully obvious when we look at charts, but defining them and exploiting them for profit is a daunting task. Many market players, including me, like to think that our success in identifying and riding trends is some intuitive skill that is akin to artistic talent. We like to believe that trend trading is an art form that can’t be easily taught or communicated. Little crushes that conceit with his systematic approach to trend trading.
He uncovers and dissects the many nuances and subtle issues that make trend trading so powerful. Trend trading isn’t just about holding a stock through a series of higher highs and higher lows. That is the easy part. Anyone can hold a stock that goes up endlessly, but, unfortunately, that doesn’t happen that much in the real world.
We have news events, shifting sentiments, and a host of factors that toss stocks around at random. Only the best stocks will continue to exhibit relative strength and reward us if we stick with them. Knowing when to hold and when to abandon ship is what this book addresses like no other that I have ever read. The easiest part of the investment or trading process is the buy point.
It is not that hard to find a stock that has a positive technical pattern. The hard part is the sell decision and that is what L. Little addresses with great precision. He integrates the concepts of volume, swing points, and anchor bars into the analysis, which greatly aids in determining the health of a trend.
In my experience, the most common mistake among active traders is that they don’t stick with trends long enough. They simply don’t have a good framework for deciding whether a trend will continue and, as the old adage goes, “no one ever went broke” taking a profit. However it can be quite disheartening to look back at how costly premature sales have been. The great difficulty in trend trading is trying to determine when a trend has ended and it is time to move on versus what is just a healthy correction within a trend.
I’ve heard countless tales about how someone bought a stock like Apple Computers at $7 in 2003 and then sold it for $10.50 and a big fat 50% profit a few months later. That sounds pretty darn good until you look at the current price of Apple Computers at around $340. There is nothing more valuable in this excellent book than the disciplined structure and set of rules it sets forth for staying with a trend and not selling prematurely. There will be times when the trend is suspect or ambivalent, but L.
Little develops a clear approach to dealing with those times so that you can stay with the trend and reap the big payoff. It is obvious to every logical thinker that trend trading is the key to market success. It is the qualification of trends and the execution of the investor that is the key to success. You will not find a better framework for trend trading than that set forth by L.
Little in this very valuable book. James “RevShark” DePorre Shark Investing Anna Maria Island, Florida Acknowledgments The lasting influences in one’s life are numerous, but none are more relished than those with close family. To my mother, the first love of my life, I extend an unending gratitude. She always provided rich encouragement laced with discipline.
Professionally I extend special thanks to my publisher for all the wonderful work and opportunities they have provided. To Elizabeth and Jayanthi from Stocks and Commodities magazine, who continue to spread the word of technical analysis far and wide. To William Hennelly and Poilin Breathnach, managing editors of TheStreet.com and RealMoney.com, whose faith in my writing and technical insight provided a much wider audience for my material. Finally, to the countless technicians, both contemporary and historical, whose writings inspired and embellished my trading methods, I thank you all.
Little Introduction Unlike men, not all trends are created equal. That simple premise, when fully understood, forever changes how you look at a chart. Trend, as it applies to securities trading, is loosely defined as the proclivity for prices to move in a general direction over a period of time. Trend direction, although generally understood as a series of higher highs and higher lows (uptrend) or lower lows and lower highs (downtrend), is largely left to the practitioner to identify and interpret, without any system of uniformity and codification.
This is a problem. A more subtle but detrimental problem is the widespread practice of treating all trends as equals. Rarely does one see any discussion or even the recognition that some trends are “better” than others. This monolithic approach to trend combined with a blindness toward quality necessarily results in inferior trading results.
To believe that all trends are equal in importance is to ignore reality. They are not. It is sometimes said that successful traders have a knack for picking the “right” stocks. Although there is a lot more to successful trading than the choice of what to trade, successful traders tend to trade “stronger” trends; their skill, however, is probably based more on intuition than consciously practiced.
Trends are the primary technical tool of almost all traders, trading indicators, and trading systems. As such, the concept of trend is embedded in almost all technical trading literature, thought, and practice. “The trend is your friend” is an often-repeated aphorism. The desire to both identify and follow trend is practiced with an almost religious zealousness.
There exists a hodgepodge of technical tools designed specifically to recognize the creation and termination of trends. The use of moving averages is probably the oldest and most widely followed method to capture trend.